Shareholders Will Be Pleased With The Quality of Hercules Site Services' (LON:HERC) Earnings

The subdued stock price reaction suggests that Hercules Site Services Plc's (LON:HERC) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

Check out our latest analysis for Hercules Site Services

Zooming In On Hercules Site Services' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2024, Hercules Site Services had an accrual ratio of -0.30. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of UK£5.7m during the period, dwarfing its reported profit of UK£1.64m. Hercules Site Services' free cash flow improved over the last year, which is generally good to see. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Hercules Site Services increased the number of shares on issue by 26% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of Hercules Site Services' EPS by clicking here.

A Look At The Impact Of Hercules Site Services' Dilution On Its Earnings Per Share (EPS)

Hercules Site Services was losing money three years ago. The good news is that profit was up 112% in the last twelve months. But EPS was less impressive, up only 102% in that time. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Hercules Site Services can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Hercules Site Services' Profit Performance

In conclusion, Hercules Site Services has strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share growth is weaker than its profit growth. Based on these factors, we think that Hercules Site Services' profits are a reasonably conservative guide to its underlying profitability. If you want to do dive deeper into Hercules Site Services, you'd also look into what risks it is currently facing. You'd be interested to know, that we found 3 warning signs for Hercules Site Services and you'll want to know about these bad boys.

Our examination of Hercules Site Services has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.